Commentary and musings on the complex, fascinating and peculiar world that is securities regulation

Thursday, November 25, 2010

UK Supreme Court Explains Fiduciary Duty Limits of De Facto Directors

The UK Supreme Court has ruled that a person who created 42 companies to service the tax and business needs of IT contractors, and also created a company to be the sole director of each of the 42 companies with himself as the director of that corporate director, was not the de facto director of each of the 42 companies. In a 3-2 opinion, the Court declined to impose fiduciary duties on the individual when all of his relevant acts were done as a director of the corporate director and could be attributed in law solely to the activities of the corporate director so long as the relevant acts were done by the individual entirely within the ambit of the discharge of the his duties as a director of the corporate director. It is to that capacity that his acts must be attributed. The individual was simply not part of the corporate governance structure of the composite companies, said the Court, and did not assume a role in those companies which imposed on him the fiduciary duties of a director.Holland v. Commissioners for Her Majesty's Revenue and Customs, UKSC 51, Nov. 24, 2010.

The 42 companies were created separately in an effort to stay below a higher corporate tax rate, a scheme that failed when UK tax authorities found that the companies were associated and imposed the higher corporate rate. The government alleged that the individual was a de facto directors of the 42 companies, which had become insolvent, and of which HMRC is the only creditor, and that he had been guilty of misfeasance and breach of duty in causing the payment of dividends to the companies’ shareholders when the companies had insufficient distributable reserves to pay their creditors.

A company is an artificial entity, said Lord Hope for the majority, a creature of statute. So it can act only through human beings. Inevitably it is human beings who must take the decisions, and give effect to them by actions, if the company is to do anything at all. It follows that persons can be validly appointed as company directors and that persons who are not directors de jure may nevertheless be treated as directors de facto. In addition, UK law allows for a company to be the director of another company and, up until the Companies Act of 2006 which required a company to have at least one natural director, to be the sole director. It followed that the corporate set up here of a sole corporate director for the 42 composite companies was proper since these events occurred before 2006.

The Court cited a key UK precedent holding that a de facto director is a person who assumes to act as a director. He is held out as a director by the company, and claims and purports to be a director, although never actually or validly appointed as such. To establish that a person was a de facto director of a company it is necessary to plead and prove that he undertook functions in relation to the company which could properly be discharged only by a director. It is not sufficient to show that he was concerned in the management of the company’s affairs or undertook tasks in relation to its business which can properly be performed by a manager below board level.

The Court said that the mere fact of acting as a director of a corporate director will not be enough for that individual to become a de facto director of the subject company. In this case, the individual charged as de facto director wasdoing no more than discharging his duties as the director of the corporate director of the composite companies. Everything that he did was done under that umbrella. Evidence that the individual director of the body corporate was actually giving instructions in that capacity to the subject company and the subject company was accustomed to act in accordance with those directions would not be enough to prove that the individual director assumed a role in the management of the subject company which imposed responsibility on him for misuse of the subject company’s assets.

In his concurring opinion, Lord Collins noted that for almost 150 years de facto directors in English law were persons who had been appointed as directors, but whose appointment was defective, or had come to an end, but who continued to act as directors. There was a striking judicial innovation in the late 1980s by which persons who were held to be part of the corporate governance of a company, even though not directors, could be treated as directors for the purposes of statutory provisions relating to such matters as wrongful trading by, and disqualification of, directors. To extend that line of authority so as to impose fiduciary duties on the individual in this case in relation to the composite companies, when all of his acts can be attributed solely to the activities of the corporate director of the composite companies would be an unjustifiable judicial extension of the concept of de facto director, and best left to the legislature, given that it was as recently as 2006 that it intervened to require that at least one director of a company be a natural person.

In dissent, Lord Walker feared that the Court’s decision will make it easier for risk averse individuals to use artificial corporate structures in order to insulate themselves against responsibility to an insolvent company’s unsecured creditors. While stopping short of calling it a sham, Lord Walker said that the Court's assertion that everything that the individual did was done in his capacity as a director of the corporate director of the composite companies and was within his authority as a director of that company, is the ``most arid formalism.'' The dissent believes that the individual was acting both as a de jure director of the corporate director and as a de facto director of the composite companies. A de facto director is not formally invested with office, reasoned Lord Walker. but if what he actually does amounts to taking all important decisions affecting the relevant company, and seeing that they are carried out, he is acting as a director of that company. It makes no difference that he is also acting as the only active de jure director of a corporate director of the company.